Abercrombie & Fitch: A Real And Distressed Valuation

Summary

• The retail industry is not as bleak as it is portrayed.
• The company is repositioning itself by focusing on online sales and closing retail stores.
• With $548 million in cash, Abercrombie & Fitch can support the impressive 6.58% dividend yield.
• At a low price of $9.59/share, the stock presents a significant potential upside.

After dropping 21.13% to a price of $9.59/share on Monday, Abercrombie & Fitch Co. (NYSE:ANF) is effectively selling on a bargain. With ANF's market cap falling 75% in less than 10 years and the stock at its lowest level since May 2000, many investors are reluctant to go near the company. Another brutal day in the market for ANF gives rise to a cliche question - How low can ANF go?

With the retail industry, in general, experiencing an impending disaster, ANF's competitors including Aeropostale, Wet Seal, and BCBG Max Azria Group have filed for bankruptcy over the past two years. However, the retail industry's outlook is not as bad as it is portrayed by the mainstream media. The retail sales grew by 4.1% over Q1 2016 and 0.3% in Q4 2016. In addition, the notion that retailers are closing stores amid changing consumer preference is nothing more than a hasty generalization. According to Greg Buzek, 19 retailers plan to open 2861 stores by the end of this year. Moreover, the retailers entering bankruptcy protection in 2017 were already on the brink of collapse before January 1st. The retail market is essentially an environment with intense competition which ensures the survival of the fittest. This is ultimately good for the industry itself.

The stalled talks between ANF and potential buyers indicate that the board has faith in its repositioning strategies. On Monday the ANF said, the best way to create value for its shareholders is “the rigorous execution of our business plan". ANF stressed that it will focus on its bright spot of growth, Hollister. The brand has a good reputation among its intended target customers which is reaffirmed by its growing sales. Hollister, alone, had sales of $1.8 billion last year which made up half of ANF's revenue. The company is also trying to reposition itself by focusing on online sales, which make up 30% of ANF's revenue. The shift in the strategy is reflected in ANF's decision to close about 60 stores in the United States by the end of this year. 50% of ANF's store leases are expiring by the end of 2018 which also signals the company's flexibility to shutter stores and discard its dead weight.

ANF's fundamentals have deteriorated substantially over the past few years. With a negative 3.60% revenue growth, -0.27 diluted EPS, and a 64% decline in EBITDA over the last year, the company's financial statement paint a bleak picture. However, these fundamentals would be substantially more troubling if ANF's valuation did not already reflect their weaknesses. In addition, ANF's cash reserves of $548 million exceed its entire current liabilities. The company's debt to capital ratio of 18.4% is also substantially lower than the industry average of 40%. The strong cash flow position of the company also provides a solid support for dividends. In 2017, ANF reported a dividend of 0.80/share. With a dividend yield of 6.58%, investors can expect a consistent return, with a huge potential for upside, as forecasted by analysts in the diagram below.

(Source: Financial Times)

With the recent 21.13% decline in its price, the stock looks to be undervalued as far as the valuation is concerned. Analysts across Wall Street have given the stock a median price target of $13/share, which represents a potential upside of more than 35%. The strong solvency ratios and consistently high dividend payouts to shareholder make a strong case for investment in ANF. In addition, the company has started taking steps to reduce its expenses by approximately $100 million, enabling investments in revenue driving activities.

ANF's stock might fall even more before the company eventually completes its repositioning strategies. However, I believe aggressive investors should be looking towards ANF as a stock with huge potential going into the future. ANF's stock provides a real and distressed valuation - something that is scarce in a bullish market. Considered in full, I believe ANF presents a good value proposition for investors at the current bargain price.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.